U.S. takes issue with Chinese exchange rate WASHINGTON - As U.S. factories continue to lay off workers, lawmakers have found something to blame: a flood of cheap manufactured goods from China. And, they say, China gives those exports an unfair advantage by making the Chinese currency - the yuan - artificially cheap compared to the U.S. dollar. The result: Chinese-made goods enter world markets at rock-bottom prices. "This policy is unfair," Rep. Mark Green, R-Wis., said at a congressional hearing on the Chinese currency earlier this month. "It is anti-competitive. It is anti-freedom. And it is costing us jobs." President Bush has weighed in, too, asking Chinese President Hu Jintao last weekend in Bangkok to let market forces determine the exchange rate. Hu agreed to study the problem jointly with the United States. Presidents don't often get involved in the abstruse details of how to manage the international financial system, and for good reason. Engineering changes in currency policy is a risky business that can have unintended and harmful consequences. Financial crises resulting from botched currency policies have been a regular feature of the world economy for the entire history of international capitalism. Indeed, that's what happened during the Asian financial crisis of 1997, when China was cast in the role of a hero for holding its currency steady and helping to halt the spread of the crisis. Despite this history, Bush and U.S. lawmakers want China to allow its currency to fluctuate against other currencies, much as the U.S. dollar, the Euro and the Japanese yen do today. Since 1994, China has locked its currency at 8.3 yuan to the dollar. Chinese officials say they want to do just what Bush is asking for, but not right away. They worry that China's banks are too weak to withstand the shock of a sudden liberalization of the currency policy. The banks have huge bad loans on their books, and only a steady inflow of yuan deposits keeps them alive. If the yuan were allowed to fluctuate, and money could flow freely in and out of the country, depositors might shift some of their money out of China. A big enough shift would cause the banks to run short of cash, causing a financial crisis that could sink the economy and send waves of instability around Asia. So Chinese officials want to get the banking system in shape before moving forward, and the truth is that a Chinese banking crisis would hardly help American workers. On the U.S. side, a stronger yuan may do less than advertised for American factory workers. Chinese imports aren't the only reason why manufacturing jobs are in decline. Factories are installing more and more automated equipment that allow production of the same amount of goods with fewer workers. And lower wages - not an undervalued currency - is probably the main reason why Chinese-made goods are cheaper than their American counterparts. Still, Fred Bergsten, who heads the Institute for International Economics in Washington, believes that a 20 percent to 25 percent increase in the value of the Chinese currency - a move to the 6.2 to 6.6 yuan to the dollar range - could translate into 500,000 U.S. jobs, mainly in manufacturing. That's only a part of the 2.8 million manufacturing jobs lost in the last three years, but it's not insignificant. A stronger yuan, at least in theory, helps U.S. factories in two ways. First, it makes U.S. exports cheaper for Chinese buyers. At 6.6 yuan to the dollar, a $10 item would cost 66 yuan instead of 83 yuan. It also makes Chinese imports more expensive for American consumers, who then might opt for American-made goods instead. But the actual impact of a stronger yuan in prices may be less than expected. For one, 80 percent of the parts in Chinese exports - which range from Motorola cell phones to Dell computers - are made in other Asian countries and elsewhere. Changing the value of the yuan won't affect the cost of those parts, at least not directly. As a result, Stanford University economist Lawrence Lau estimates that a 20 percent increase in the value of the yuan would push up the cost of Chinese goods only about 4 percent. Even those costs might not get passed on to consumers in today's highly competitive economy. Companies that export from China - many of them American - may absorb the exchange rate shift, taking a cut in profits instead. "Forcing China to revalue does not really help us solve our job problem fundamentally," Lau told a congressional hearing on China trade last month. Nonetheless, Chinese officials have indicated repeatedly that they eventually want the yuan to fluctuate against other currencies. That would allow the central bank to use interest rates to fight inflation or unemployment, as in the United States, rather than just to maintain the exchange rate. But Bergsten of the Institute for International Economics worries that China won't move fast enough to satisfy America's politicians. Chinese officials have suggested to him that China might change its exchange rate policy around the time of the Beijing Olympics, set for 2008. By then, he fears, U.S. trade policy will have turned protectionist.

President Bush's week-long swing through six Asian nations is long overdue. Despite being home to half the world's population and the globe's most dynamic economies, Asia has received scant attention from this administration. Unfortunately the president has only one subject on his agenda -- the war on terrorism. The president is touching lightly, if at all, on the other issues that matter most to this region -- economic globalization, China's growing presence, and political instability fed by economic disparities. This is not surprising. The Bush administration doesn't seem to think much about global economic issues. And when it does speak, as it has recently on the issue of currency manipulation by China and Japan, the administration's policy is confusing and contradictory. In Asia, the single-minded focus on terrorism leaves an opening for others -- China first of all -- who are more in tune with the region's concerns. "I've never seen a time when the U.S. has been so distracted and China has been so focused,'' Ernest Bower, the head of the U.S. business council for Southeast Asia, told a business magazine.

Regional economic bloc

Faced with multiple challenges, the countries of Southeast Asia have accelerated plans to create a regional economic bloc like the European Union. The Chinese, followed closely by India and Japan, are embracing the idea, proposing the creation of a vast East Asian free trade area that would encompass nearly 2 billion people, but notably not include the United States. When national security adviser Condoleezza Rice briefed reporters on the president's trip, the focus was almost entirely on security issues. Bush's itinerary is designed to highlight the nations working closely with the United States to combat Al-Qaida-linked Islamist terror groups in Southeast Asia -- Singapore, the Philippines, Indonesia and Thailand. Or to reward those who are backing the war in Iraq -- Japan and Australia. Even at the annual Asia Pacific Economic Cooperation summit in Bangkok, Bush plans to `"stress the need to put security at the heart of APEC's mission because prosperity and security are inseparable,'' Rice said. No one can argue with that basic proposition. The example she cited was the terrorist bombing a year ago in Bali, Indonesia, which shut down tourism, a vital source of income for Indonesians. But let's not look at that link through the wrong end of the telescope. We need to grapple with the poverty and income inequality in Indonesia, the world's largest Muslim-populated nation, which feeds growing Islamic radicalism.

China drives growth

East Asia has largely emerged from the financial crisis that swept through this region in 1997-98 and sent countries such as Indonesia into economic collapse. Economic growth should pick up to almost 6 percent next year, the World Bank has predicted. But much of this is driven by China's rapid growth, which is in turn sparking a sharp rise in trade within the region, much of it between countries in the region and China. These countries look warily on this rising giant. China is sucking away foreign investment from places like Silicon Valley that used to flow to them, and with it, jobs. At the same time, progress toward a global free market that ensures fair competition has stalled. The world trade talks in Cancun last month collapsed in rancor, and the United States seems content now to pursue its own bilateral trade deals with favored countries such as Singapore and Australia.

10-nation association

This has encouraged the 10-nation Association of Southeast Asian Nations to accelerate plans to create a European Union-style economic community. The Chinese sent a huge, high-powered delegation led by their premier to their recent meeting, signed a friendship treaty with the group and pledged to negotiate a free-trade zone with the group. "The Chinese are moving in in a big way,'' says Stanford University expert Donald K. Emmerson. Where is the United States in all this? "We're outside, and our businesses are going to be outside,'' says Brookings Institution global economic expert Lael Brainard. "The Bush administration needs to get a handle on this.'' If it doesn't, the United States will wake up one day from its infatuation with unilateralism and return to Asia to find that the furniture has been rearranged and the locks have been changed.

Perhaps no other country has more to lose from North Korea's acquisition of a sizeable nuclear arsenal than China. The existence of such weapons would not only endanger the city of Beijing but also provoke a regional arms race in which Japan, South Korea, and possibly even Taiwan would eventually develop their own strategic deterrents. Given these facts, it is surprising that China has not acted more forcefully to persuade Pyongyang to terminate its nuclear program.

The explanation for this reluctance is the importance Beijing attaches to regional stability. If the North Korean regime were to collapse, a refugee crisis would ensue as starving people flooded across the border into northeastern China, and the way would be opened for South Korean and American troops to advance up the peninsula towards Beijing.

If the Bush administration wants to enlist Chinese help against Pyongyang, therefore, it must first assuage these very reasonable concerns.

China's importance to the United States stems from the absence of other sources of leverage over Pyongyang. Military action against North Korea is an unattractive option because Kim Jong Il and his generals could retaliate massively. Promises of long-term economic aid in exchange for Pyongyang's renouncing its nuclear aspirations also offers little hope. Kim has a long record of consenting to such deals and then surreptitiously reviving his armament efforts.

What is needed is an intermediate form of suasion. China is the only power that possesses this sort of leverage. According to South Korean analysts, in 2002 China supplied 31 percent of North Korea's imports and accounted for 37 percent of its exports. In addition, each year Beijing gives several hundred thousand tons of food aid to its troublesome neighbor, and, now that the United States and Japan have suspended their oil shipments, provides the preponderance of its fuel.

Beijing has occasionally used its influence to express discontent with North Korean behavior, and, by all accounts, the diplomatic dialogue between the two states has also become more acrimonious of late.

However, Beijing will presumably not press Pyongyang much further unless it is assured of the Bush administration's goodwill. In practice, this means that Washington must identify and alleviate China's specific geopolitical concerns. If Beijing fears a refugee crisis, then the United States and its allies must promise to help finance the care of the displaced and perhaps to absorb some significant number of North Korean emigrants. If Beijing fears the approach of American military forces, Washington should consider promising to limit U.S. activities north of the demilitarized zone.

While demonstrating that the United States is willing to accommodate China's needs, the Bush administration must also prove that Pyongyang's policies represent an immediate threat to East Asian stability. To do this, Washington needs to engage more frequently and more conciliatorily in diplomatic talks with Kim and his representatives. For with each abortive discussion, each rejection of reasonable American gestures, the North Koreans push Beijing closer to the conclusion that they pose an unacceptable danger to China's national security interests.

The effect of this policy of dual engagement with China and North Korea would almost certainly be positive. As Beijing's attitude towards Pyongyang hardened, the world might see a sharp reduction in its oil shipments, the deployment of more troops to the North Korean border, or overt discussions with the United States about the future of the peninsula. This would be the strongest possible signal to Pyongyang, short of war, that the world will not tolerate its emergence as a major nuclear power. If, on the other hand, he remained intransigent until the intensified pressure caused North Korea to collapse, Washington and Beijing would still be relatively well situated to deal with the ensuing challenges.

It is through the joint resolution of serious challenges that potential rivals like the United States and China learn to trust each other. If there is a silver lining to the North Korean cloud, it is this opportunity to improve bilateral communications in anticipation of future exigencies.

The writer is a fellow at the Asia-Pacific Research Center, Stanford Institute for International Studies.